The Duty of Directors and Officers to Refer Business Opportunities

Dear clients and friends,

Recently, two District Courts ruled on the issue of the fiduciary duty of directors and officers to refer opportunities to the companies in which they serve and the prohibition on exploiting such opportunities, even if the company itself is unable to pursue them.

Biton v. Pangaya

On October 21, 2013, the Economical Department of the District Court of Tel Aviv-Yafo (by the Hon. Denya Keret-Meir) ruled in Derivative Motion 20136-09-12 Eliyahu Biton v. Pangaya Real Estate Ltd et al.  Pangaya, a company involved in real estate investments, received a real estate investment opportunity through certain of its directors and officers. Both the audit committee and the board of directors of the company turned down the opportunity due to lack of resources. The introducing directors and officers went on to pursue the opportunity independently from the company.

The petitioner, a shareholder of Pangaya, filed a motion to approve a derivative claim against such directors and officers, arguing that the directors and officers who had introduced the real estate investment opportunity to the company, were precluded from independently pursuing it. The petitioner also contended that the directors and officers misrepresented to the audit committee and the board of the company material aspects regarding both the investment opportunity and its funding requirements, which may have affected their decisions.

The District Court granted the motion and approved the filing of a derivative claim against such directors and officers, notwithstanding the fact that the company might not have been able to execute such investment opportunity due to lack of resources. The District Court noted that a transaction, which a company does not have the financial ability to pursue, is nevertheless a business opportunity of the company, which directors and officers are precluded from exploiting. The District Court reasoned that if this was not the case, directors and officers may not try to have the company recover from adverse financial situations in order for them to be able to pursue such opportunities themselves.

Chitron v. Teler

On December 17, 2013, the District Court for the Central District (by the Hon. Abraham Jacob) ruled on this issue. The plaintiffs in Civil Claim 13484-03-09 Gad Chitron et al. v. Adi Teler et al., who were shareholders in a company, contended that the defendant, who at the relevant period acted as the CEO of such company, had breached his fiduciary duty towards the company and its shareholders by pursuing the company’s business opportunity through a company wholly owned by the defendant that was incorporated for such purpose. The disputed actions involved the defendant independently initiating negotiations with a prospective key client of the company, with whom the company previously had negotiated (through the defendant), without reaching an agreement.  The products and services offered by the defendant’s wholly owned company to the key client were similar (albeit not identical) to those that were being developed by the company for the key client. The defendant’s wholly owned company and the key client ultimately entered into a business transaction for the provision of such products and services.

Notwithstanding the failure of the negotiations between the company and the key client, and notwithstanding the fact that the products and services offered by the defendant’s wholly owned company to the key client were not identical to those proposed by the company, the District Court ruled that the mere initiation of negotiations by the defendant, through his owned company (that ultimately concluded with the entering into a business transaction), while acting as the CEO of the company – constituted a conflict of interest and breach of his fiduciary duties towards the company.

Moreover, the District Court ruled that although normally a fiduciary duty of a director and officer applies exclusively towards the company, in this case, the special relationship between the defendant and the plaintiffs (who were parties to a founders agreement) together with the fact that the defendant negotiated with the prospective key client on behalf of the company and the founders in their capacity as his business partners, established a fiduciary duty of the defendant directly towards the plaintiffs under the laws of contract and agency.

We note that both rulings may be subject to additional review and appeal, and may therefore not be the final word on this matter.

This publication provides general information and should not be used or taken as legal advice for specific situations, which depend on the evaluation of precise factual circumstances.

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